Draghi's Deadly Derangement

By David Stockman. Posted On Thursday, March 10th, 2016

Yes, the man is totally deranged, and so is the entire eurozone policy apparatus. Like much of officialdom elsewhere in the world, the ECB is attempting to fight low growth and low inflation with monetary nitroglycerin. Its only a matter of time before they blow the whole financial works sky high.

Low real GDP growth in the eurozone has absolutely nothing to do with the difference between -0.3% on the ECB deposit rate versus the new -0.4% dictate announced this morning; nor does QE bond purchases of EUR 80 billion per month compared to the prior EUR 60 billion rate have anything to do with it, either. The only purpose of such heavy handed financial intrusion is to make borrowing cheaper for households and businesses.

But here's what the moronic Mario doesn't get. The European private sector don't want no more stinkin' debt; they are up to their eyeballs in it already, and have been for the better part of a decade.

The growth problem in Europe is due to too much socialist welfare and too much statist taxation and regulation, not too little private borrowing. These are issues for fiscal policy and elected politicians, not central bank apparatchiks.

As shown in the chart below, the eurozone private sector had its final borrowing binge during the initial decade of the single currency regime through 2008; debts outstanding grew at the unsustainable rate of 7.5% annually. But since then the eurozone private sector has self-evidently been stranded on the shoals of Peak Debt.

Outstandings have flat-lined for the past eight years----not withstanding increasingly heavy doses of ECB interest rate repression that have finally taken money market rates into the netherworld of subzero.

Nor has the approximate EUR $700 billion of bond purchases since QE's inception last March made one wit of difference. Bank loans outstanding to the private sector were EUR 10.24 trillion at the end of January or exactly where they stood in March 2015 when Draghi and his merry band of money printers went all in.

By the same token, it is damn obvious that low inflation is not a problem, and that, in any event, it is not caused by lack of money printing and insufficient interest rate repression by the goofballs assembled at the ECB's swell new headquarters in Frankfurt. The eurozone's respite from its normal 1-2% annual dose of headline inflation is entirely imported via the global tide of plunging oil, commodities, steel and other industrial prices.

That welcome tide of imported deflation, in turn, is actually improving the eurozone's terms of trade and raising consumer living standards; and it is not remotely connected to anything the ECB has done or not done in the last year or even four years.

Instead, the global deflation is a consequence of the massive malinvestment in mining, energy, industry, transportation and distribution which has resulted from the 20-year global credit binge enabled by the world's convoy of money printing central banks. Incremental debt of $185 trillion or nearly 4X GDP growth during that period has crushed the world's capacity for investment and production led growth.

The overhang of excess capacity everywhere on the planet is also drastically compressing prices, margins and profits, but the major impact is in the Red Ponzi and its EM supply chain; and the secondary impact is on engineered machinery, high tech and luxury goods exporters, including Germany and other eurozone export strongholds.

It goes without saying, however, that today's new round of monetary quackery by the ECB will have no impact whatsoever on eurozone export demand from China and the EM. Not only did Draghi fail to send the Euro careening lower, but it wouldn't matter anyway. The barrier is not FX; the problem is investment saturation in foreign markets that have run out of borrowing capacity.

In any event, the global deflation is actually a boon to eurozone workers and consumers because Europe is a giant energy and materials importer.

So what if that windfall to living standards in the old age colony now planted on the european continent causes the headline inflation indices to temporarily flat line?

Do the Keynesian madmen at the ECB really think that the hundred million or so eurozone households living essentially hand-to-mouth on stagnant wages and welfare will actually stop buying food, clothing, shelter, shoes, movie tickets, bedroom furniture and backyard garden tools because they are waiting for prices to go down?

In a world of peak debt and stagnant wages, the idea of a deflationary buyers strike is just self-serving bureaucratic jabberwocky.

The truth is, the whole central bank anti-deflation gambit is based on an egregious and self-created strawman. Namely, the utterly bogus notion that 2.00% headline CPI inflation is the magic elixir of economic performance. Yet there is not a shred of evidence to support it; it has come to prevail as a policy norm purely as a matter of assertion and ritual incantation.

In fact, the whole central bank inflation targeting regime has degenerated into the monetary equivalent of counting angels on the head of a pin in the manner of medieval theologians. If you even set aside just oil and energy------which absolutely is not produced within the borders of the eurozone------you get the picture shown below.

To wit, since the inception of the single currency in 1999, the harmonized consumer price index less energy (and seasonal food) has advanced at a 1.57% rate per annum. During the eight years since the great financial crisis in 2008 it has gained by 1.21% per annum; and, assisted by the declining price of Europe's raw materials and other non-energy imports, the index rose by 1.01% during the year ending in January.

So c'mon. Is there one iota of economic logic or common sense which suggests that a mere 36 basis point, or 56 basis point deviation, respectively, from a deeply embedded 17-year trend is enough to cause the $13 trillion eurozone economy to sink into some kind of macroeconic black hole? And one so devastating that it can only be remedied by what is essentially a criminal assault on savers and a windfall to speculators?

It can now be well and truly said that the ECB and other central bankers are so far down the rabbit hole that they have completely lost contact with common sense. They are trifling with microscopic two decimal point variations in consumer inflation rates which are utterly irrelevant to the economic welfare of the 19-nations which comprise the eurozone.

The only welfare involved, in fact, is that of the front-running financial gamblers who stalk the world's financial markets waiting for the next outbreak of central banker foolishness. A few days ago, for example, the fast money made a killing when the yield on the 30-year Japanese government bond was driven to a mere 47 basis points.

As we pointed out at the time, Japan is hurtling toward fiscal and demographic bankruptcy. So the only explanation for that mindless breakout is that front-runners were scooping up these 30-year JGBs on the massive leverage of the repo market, knowing they could harvest their gains at the open market desk of the BOJ.

Yet that's where the monetary nitroglycerine comes in. As Zero Hedge pointed out this morning, even that gambit has it limits. When the central banks finally run out of credibility and capacity to indulge is sheet economic irrationality, as NIRP surely is, there will be no bid for financial market front runners' returning their bond rentals.

Then, look out below. There was already a hint of that in the tattered remnant of Japan's bond market yesterday.

Japan’s negative-rate experiment has found a new market to roil: Japanese government bonds. The tempestuous times are probably just starting.

Yields on JGBs swung wildly this week, after unexpectedly high demand at an auction for 30-year bonds. Volatility on these bonds rose to the highest since at least 2000. The proximate cause: The usual buyers of long-term bonds such as life-insurance companies sat back as Japan’s big banks rushed in.

Banks have an incentive to own the long-dated bonds: They are becoming a scarce commodity—something that still has positive yields, however infinitesimal. Shorter-duration bonds have negative yields. And because of the new negative-rate policy, when banks sell bonds to the Bank of Japan83014.61% as part of quantitative easing, they end up with cash in a negative interest-bearing reserve account. They have an incentive to hug these 30-year bonds tight.

That rush has also generated quick capital appreciation on the bonds. Some investors clearly took profits after 30-year yields plunged 0.25 percentage point to 0.48%, a massive move in this otherwise sleepy corner of the market. Yields bounced back up Wednesday and Thursday.

Whether the BOJ’s negative-rate policy will work to spur the economy is an open question. What’s clearer is that it has worked to make Japan’s government bonds the best performers among developed markets this year, mostly on capital appreciation terms. Since the introduction of negative interest rates at the end of January, Japan’s government-bond yield curve out to 10 years has gone subzero, meaning more than 80% of the stock of bonds have negative yields.

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